page in the Commissions Questions & Answers
series examines issues arising from the payment
of earnest money deposits prior to closing a residential
real estate sales transaction. Since payments made
before closing are not treated the same in all transactions,
it is important to understand the purpose of earnest
money and how it will be handled during the transaction.
This is usually spelled out in the offer to purchase
or sales contract.
Therefore, you should always
read the contract or offer to purchase before paying
any money and CONSULT YOUR OWN ATTORNEY IF YOU DO
NOT UNDERSTAND THE PURPOSES AND DISPOSITION OF ANY
PAYMENT OR ANY OTHER TERMS IN THE CONTRACT OR OFFER.
The questions raised in this
publication are of special concern to real estate
purchasers. Consequently, they are posed from the
standpoint of the purchaser.
What is earnest money?
It is money you give to the seller
(or the sellers agent) to show your good faith
when making an offer to purchase the sellers
Do I have to pay an earnest money deposit to have
a valid contract?
Although no law requires it, sellers
typically do require it. If you agree to pay earnest
money but do not make the required payment or your
earnest money check bounces, you will
probably be considered in breach of the contract.
How much earnest money should I pay?
The amount is negotiated between
you and the seller. It is typically a small percentage
of the purchase price and can vary depending upon
local market conditions, the price of the property,
the type of property (e.g. vacant land, existing
housing, or new construction), whether cash advances
to a builder or seller are involved, and other factors.
What happens to the earnest money before closing?
The purchase contract governs where
earnest money will go. It should also specify the
amount(s) to be paid, when the payments are to be
made, whether the money will be held in a trust
(escrow) account, who will hold it, whether it will
be credited against the purchase price at closing,
and what may happen to it if the transaction does
Will my earnest money earn interest between contract
Probably not. Most earnest money
is held by real estate brokers in non-interest-bearing
trust or escrow accounts. In order for the money
to earn interest, the buyer and seller must agree,
and they also must determine who will earn the interest.
Such an agreement should be included in the purchase
contract and may require the assistance of an attorney
Who can hold earnest money?
Any person (or entity) agreeable
to you and the seller, but usually a licensed real
estate broker. As a buyer, be aware that if you
allow earnest money to be held and deposited by
a seller or by a builder or developer for use in
construction, you risk that they will not be able
to return it to you in the event the transaction
does not close (due to the sellers death,
divorce, bankruptcy, judgment liens, receivership,
fraud, tax liens, title problems, etc.). Consequently,
most buyers prefer to have real estate agents or
attorneys hold the earnest money deposit. Since
they are licensed by the state and required to deposit
the money in a trust or escrow account, this reduces
the risk that the monies will be improperly used.
Under the standard Offer to Purchase and Contract
form*, who holds the earnest money?
The form permits the parties to select
who will hold the money - typically, the listing
firm. Whenever a licensed real estate firm or agent
holds any earnest money, it must be deposited in
a trust or escrow account until closing. However,
if any addenda are used with the form, check to
see whether they conflict with any provisions in
the form concerning who will hold the earnest money
or other pre-closing deposits.
*The Standard Form No. 2-T, Offer
to Purchase and Contract is a well-known and widely
used form jointly adopted by the North Carolina
Bar Association (a voluntary professional association
of attorneys) and the North Carolina Association
of REALTORS ® (a voluntary professional organization
of real estate agents).
Is earnest money the same as a due diligence fee?
No. The due diligence fee
is a separate, nonrefundable fee a buyer may pay
for a negotiated period of time (the due diligence
period) during which the buyer may perform
inspections, obtain loan approval, schedule a property
survey or appraisal, review restrictive covenants,
and determine whether or not to proceed with the
purchase. The due diligence fee is paid directly
to the seller under the standard Offer to Purchase
Before the end of the due diligence
period, the buyer has the right to terminate the
contract for any reason or no reason at all, while
the seller remains bound by the terms of the contract.
Buyers typically want to negotiate the lowest due
diligence fee for the longest due diligence period,
while sellers want to negotiate the highest fee
for the shortest period. Regardless, just like the
earnest money deposit, no due diligence fee is required
If a buyer wants the seller to
make repairs, the buyer should ensure that all repairs
are made before the expiration of the due diligence
period, or have the parties enter into a signed,
written agreement to have the specific repairs completed.
While the due diligence fee is non-refundable, except
in the event a seller breaches the contract, the
due diligence fee is typically credited to the buyer
What if the standard contract form is not used?
Many developers, builders, employee
relocation services and lenders asset managers
use their own sales contract forms. Generic contract
forms are also commonly available and can now be
found on the Internet. Many will require you to
make an earnest money deposit or similar deposit,
but they may differ from the standard form in how
it is to be handled. For example, unlike the standard
Offer to Purchase and Contract form which contains
inspection and repair provisions, title requirements
and other protections, there may be no provision
allowing you to obtain a refund of the earnest money
under any circumstances. Therefore, you must read
every contract form carefully and consult with your
attorney if you have questions.
If a contract contains a rescission (cooling
off) period, can I get my earnest money back
if I cancel the contract during that time?
A: Probably; however,
most purchase contracts do not have a rescission
period. Only in certain kinds of transactions will
you be allowed (for a limited time) to cancel the
contract. These transactions include developer offerings
of condominiums, timeshares, and interstate land
sales; and where a seller fails to give you certain
disclosures in a timely manner, including the Residential
Property Disclosure Statement and, (for properties
built before 1978) the lead-based paint disclosure.
These rescission rights are usually created by state
or federal law. The amount of time varies but is
typically only a few days. You should consult your
own attorney about rescission rights in such transactions.
Isnt there a federal law that allows me to
rescind my home loan and get my earnest money back?
No. Although there is a federal law
that gives you three days to cancel a home loan
commitment, it does not give you the right to cancel
a purchase contract and get a refund of your earnest
money. Your obligation to purchase as set forth
in the sales contract is unrelated to your right
to obtain the best possible loan or avoid a loan
that has hidden conditions. However, the standard
Offer to Purchase and Contract form has a provision
allowing you to cancel the contract for any reason
or no reason prior to the expiration of the due
diligence period agreed to by the parties.
If you cancel the contract during the due diligence
period, you will get a refund of your earnest money
deposit, although you would lose any fee you paid
for the right to terminate during the due diligence
Under the standard Offer to Purchase and Contract,
do I get my earnest money back if the transaction
does not close?
It depends on why the contract isnt
consummated. If the transaction does not close due
to your inability to fulfill your contractual obligations
(such as your failure to obtain necessary financing),
the seller would be entitled to retain the earnest
money deposit plus any due diligence fee, but would
not be entitled to any other damages. Conversely,
if the transaction does not close due to the sellers
material breach (such as the inability to deliver
marketable and insurable title), the buyer would
be entitled to recover the earnest money deposit
and due diligence fee, together with reasonable
costs actually incurred by you during the due diligence
process (for example costs incurred for a survey
and property inspection) in addition to other remedies
available at law.
What if the contract fails and the seller and I
cannot agree on who is entitled to the earnest money?
According to the terms of the standard
Offer to Purchase and Contract and the rules governing
real estate brokers, if there is a dispute between
you and the seller over the return or forfeiture
of an earnest money deposit, the broker holding
the money must continue to hold the funds in trust
until you and the seller resolve the dispute in
writing or until a court decides the matter (less
than $5000, Small Claims Court; more than $5000,
usually District or Superior Court although some
cases may go to federal court). The parties may
also resolve disputes through voluntary or courtordered
mediation. Alternatively, the broker holding the
money may choose to pay the disputed funds to the
Clerk of Court in the county where the property
is located after first providing 90 days written
notice to you and the seller. If the disputed funds
are deposited with the Clerk of Court, you would
have to initiate a special proceeding with the Clerk
to recover the funds. If no one institutes a special
proceeding within a year of the funds being deposited
with the Clerk, it will be deemed unclaimed and
delivered to the State Treasurers Office as
If an attorney for you holds
the earnest money, the attorney must hold or dispose
of the funds in accordance with the rules of the
North Carolina State Bar. When a form other than
the standard Offer to Purchase and Contract is used,
it may allow the seller access to the money whether
or not the closing occurs as scheduled. In any event,
while a broker is not allowed to pursue a claim
for earnest money for you, the broker may appear
as a witness in court.